An Educated Speculation

By Fleming Meeks

IT’S BEEN A ROUGH 12 months for student lender (ticker: SLM). First the credit markets froze up, impairing the company’s ability to fund new loans. Then, in February, President Obama called for the elimination of all federally-subsidized student loans. From June of last year to the market trough in March, the company’s shares lost nearly 90% of their value.

While investors gave the stock a failing grade, we thought the punishment a bit too harsh. In an April Alert, when the shares were at $6.69, we pointed out that the runoff value of the company’s billion dollar federally-backed loan portfolio—that is, the net present value of guaranteed future cash flows—was at least $10 a share (“Sneakin’ Sallie Through the Alley”). We said the stock could double.

A month later the shares had slumped back to $5.56, and we said they looked like an even better bet. Yesterday the stock closed at $8.11. It could move up to $20 over the next year.

The Obama administration argues that it will save $4 billion a year by cutting out the middle men, like Sallie Mae, and making loans directly to students. That may be true. But while the government will be the lender, the nuts-and-bolts work of originating the loans and servicing them on the back end is better off in the hands of the private sector. SLM, we predicted, would get a sizeable piece of that action.

On Wednesday, the Department of Education announced that four companies, including SLM, had received five-year contracts, to begin in August, to service $550 billion in federal student loans. The terms of the contracts weren’t announced, but SLM, the largest and most efficient of the four operators, could get a third of the business.

Servicing the government’s loans could add 15 cents a share to SLM’s earnings the first year, 30 cents the second year and on up to $1.50 a share by year 10.

The next announcement, which could come in a few months, will likely be an outsourcing deal for loan originations. That could add another 50 cents a share to SLM’s profits.

With liquidity concerns lifting, “people have stopped worrying about the doomsday scenario,” says a hedge fund manager who owns the shares. “Now they’re concentrating on what could be.” He thinks the company could earn $1.20 a share three or four years out, and grow at a mid-teens rate from there—not including the substantial run-off earnings from SLM’s $165 billion federally-guaranteed loan portfolio. “I really don’t see any downside,” he says.

It’s worth noting that instead of whining and asking for handouts, Sallie Mae’s management quickly recognized the new reality of the student loan industry and worked constructively with policy makers to achieve their goals. Students, shareholders and federal government will all be the beneficiaries.

Fleming Meeks is executive editor of Barron’s and the founding editor of Barron’s Daily Stock Alert. He previously served as editor of SmartMoney, The Wall Street Journal Magazine, and assistant managing editor of Barron’s. Meeks began his career in journalism 25 years ago as a staff writer for Forbes. He holds a B.A. degree from Windham College.If you have comments or questions, please contact him at fleming.meeks@barrons.com

David Englander is a staff writer for the Barron’s Daily Stock Alert. He joined in 2008 as a reporter. Prior to Barron’s, he worked as a consultant, advising Fortune 500 companies on growth strategies and mergers and acquisitions. He has also worked as an independent equity analyst. Englander holds a B.A. from Amherst College, an M.B.A. from the University of Rochester and an M.F.A. from Columbia University.If you have comments or questions, please contact him at david.englander@barrons.com

Alexander Eule has been a staff writer for Barron’s Daily Stock Alert since 2010 and a reporter for Barrons.com since 2006. Prior to the Stock Alert, Eule wrote the site’s Barron’s Take and Weekday Trader features, offering frequent insights into individual stocks and the broad market. He holds a B.A. from Columbia College and an M.S. in Journalism from Columbia University.If you have comments or questions, please contact him at alexander.eule@barrons.com